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Robust Policymaking in an Uncertain, Multi-Objective World Simon Potter, Markets Group, Federal Reserve Bank of New York September 21, 2015 I would like to thank Meg McConnell for help in producing this Deck and numerous insightful conversations on these topics over the years. The views expressed in this presentation are my own and do not necessarily reflect the views of the Federal Reserve Bank of New York of the Federal Reserve System. Road Map 1. Overview of a “generic” policy framework 2. Comparison of current macroeconomic, macroprudential and microprudential frameworks 3. Consideration of role for “unconventional” monetary policy tools © FRBNY 2 What are monetary policymakers, regulators, supervisors, and conduct agencies trying to do? o Transform a set of authorities into outcomes consistent with the achievement of their objectives Authorities Macroeconomic Objectives Economic and financial environment Macroprudential Objectives Microprudential Objectives Sustainable economic growth over time © FRBNY 3 What capabilities does the official sector need to effectively transform authorities into objectives? o Measure the world: Identify concrete observable metrics for policy objectives, and identify gaps between objectives and the environment o Interpret the world: Determine when and what type of intervention in the environment is needed to promote objectives o Influence the world: Intervene in environment to address gaps between measured conditions/behaviors and objectives o Learn and adapt: Continuously update the effects and efficacy of interventions to remain effective in promoting objectives over time © FRBNY Authorities Macroeconomic Objectives Economic and financial environment Macroprudential Objectives Microprudential Objectives Sustainable economic growth over time 4 Two general observations on the current state of policymaking for central banks and close cousins • (1) Tendency to “silo” the pursuit of macroeconomic and macroprudential, and microprudential objectives (Bank of England currently trying to push against this), including: o o o o Monitoring Analysis Decision-making Deployment of tools Implication: • Tends to mask the presence of shortterm conflicts/tradeoffs across objectives that can hinder ability to achieve goal of sustainable growth over time © FRBNY Authorities Macroeconomic Objectives Economic and financial environment Macroprudential Objectives Microprudential Objectives Sustainable economic growth over time 5 Two observations on the current state of policymaking • (2) Macroprudential policy frameworks (the set of basic capabilities) are underdeveloped relative to frameworks for macroeconomic and microprudential objectives • [See table on next slide] Authorities Macroeconomic Objectives Economic and financial environment Macroprudential Objectives Microprudential Objectives Sustainable economic growth over time © FRBNY 6 (Informal and Subjective) Assessment of Current Policymaking “Capabilities” by Type of Objective Type of capability: Type of objectives: Macroeconomic Microprudential Macroprudential I. Measuring the world: Understanding how the economic and financial environment is evolving relative to objectives Identifying concrete, observable metrics/targets for objectives Measuring, monitoring and analyzing developments in real time Identifying gaps btw actual conditions and objectives on timely basis II. Interpreting the world: Determining when and what intervention in the environment is needed to promote objectives Establishing common thresholds for what constitutes a “material” gap Determining in real time whether thresholds have been breached III. Influencing the world: Intervening in environment to address gaps between measured conditions and objectives Developing reliable and effective tools for intervening in environment Determining which tool(s) can most effectively address a given gap Promptly executing on a decision to deploy a tool to address a gap Maintaining an intervention (i.e. desired policy stance) as necessary IV. Learning and adapting: Remaining effective in promoting objectives over time Evaluating monitoring/analysis, metrics/targets, tools, and thresholds Making timely adjustments to above as necessary to remain effective © FRBNY Very low Low Medium High Very high 7 The gaps in our macroprudential frameworks… • are not a new problem… “The most important characteristic of sound supervisory policy is that its impact on the banking system and the economy as a whole be salutary, rather than considering only each individual bank in isolation, as has unfortunately been customary among examiners.” - Bach, Journal of Finance, Dec 1949 “But if the banker plays an important role [in the broader economy], the supervisory agencies should be on the side of encouraging a generally beneficial use of this role. The goals of banking supervision must run beyond the "soundness" of their individual institution and simple rules of safety; they should comprehend the encouragement of sound developments in the banking system as a whole.” - Robinson, Journal of Finance, Mar 1950 • …but there is renewed urgency… “Going forward, a critical question for regulators and supervisors is what their appropriate ‘field of vision’ should be. Under our current system of safety-and-soundness regulation, supervisors often focus on the financial conditions of individual institutions in isolation. An alternative approach, which has been called systemwide or macroprudential oversight, would broaden the mandate of regulators and supervisors to encompass consideration of potential systemic risks and weaknesses as well.” - Chairman Bernanke, “Reducing Systemic Risk,” August 2008 © FRBNY 8 Real time learning and adapting needs robustness to achieve sustainable growth goal Chairman Greenspan, 2005: Chairman Bernanke, 2008: • …advances in complex financial products… , and expanded the opportunities for, …The new instruments of risk dispersal have enabled the largest and most sophisticated banks, in their credit-granting role, to divest themselves of much credit risk by passing it to institutions with far less leverage… • …more fundamentally, the turmoil was the product of a global credit boom, characterized by , excessive leverage by financial institutions, and an than the one that existed just a quarter-century ago. After the bursting of the stock market bubble in 2000, unlike previous periods following large financial shocks, no major financial institution defaulted, and . © FRBNY . The unwinding of this boom (and the associated financial losses) has led to the withdrawal of many investors from credit markets and deleveraging by financial institutions, both of which have . 9 On the role of LSAPs and negative interest rates During the financial crisis, many advanced economy central banks hit the zero bound on overnight interest rates o This had the effect of reducing the efficacy of the main tool deployed in pursuit of macroeconomic objectives Situation motivated the deployment of two “new” types of tools o Large scale asset purchase programs - Mostly viewed as acting through a portfolio balance rather than monetary base channel o Reducing overnight rates below zero © FRBNY 10 On the role of LSAPs and macroprudential objectives LSAPs and negative rates were primarily deployed to achieve macroeconomic objectives, but may also be relevant for macroprudential objectives o For example, the use of LSAPs might exert influence (intentional or unintentional) over macroprudential conditions - Buying certain asset back securities vs. changing regulatory risk weights on certain asset back securities o In terms of ease of implementation, a purchase tool might be faster and easier than many of the other tools referenced in the context of macroprudential objectives Many open questions o Would we understand what mix of purchases would improve the safety and soundness of the system (however, this applies to other tools as well)? o More generally, can we yet measure our macroprudential objectives well enough to reliably deploy any tool to achieve them? - E.g., is the mix or pace of credit creation macroprudential or macroeconomic? © FRBNY 11